9.2 Account for Uncollectible Accounts Using the Balance Sheet and Income Statement Approaches

Uncollectible Accounts

Uncollectible accounts (also called bad debts) are accounts receivable that cannot be collected from customers.

Why Accounts Become Uncollectible:

• Customer bankruptcy
• Customer financial difficulties
• Customer disputes
• Customer disappears
• Economic conditions

Accounting for Uncollectible Accounts

There are two approaches to accounting for uncollectible accounts:

1. Direct Write-Off Method: Write off accounts when they become uncollectible
2. Allowance Method: Estimate uncollectible accounts and create allowance

Luxembourg Requirement: Allowance method is preferred and often required for accurate financial reporting.

Direct Write-Off Method

How it Works:

• No estimate made
• Account written off when determined uncollectible
• Bad Debt Expense recorded at that time

Example:

• Customer account of €500 determined uncollectible on December 15

Journal Entry:

650000 Bad Debt Expense           €500
410000 Accounts Receivable                    €500
To write off uncollectible account

PCN Account:

• 650000: Bad Debt Expense (Class 6 - Expenses)

Disadvantages:

• Doesn't match expense with revenue (violates matching principle)
• Receivables overstated until write-off
• Not allowed under some accounting standards

Allowance Method

How it Works:

• Estimate uncollectible accounts at end of period
• Create allowance account (contra-asset)
• Write off specific accounts when uncollectible
• Matches expense with revenue

Two Approaches:

1. Balance Sheet Approach (Aging of Receivables)
2. Income Statement Approach (Percentage of Sales)

Balance Sheet Approach (Aging of Receivables)

How it Works:

• Analyze receivables by age
• Apply different percentages to each age category
• Calculate total estimated uncollectible
• Adjust allowance to this amount

Aging Schedule Example:

Aging of Accounts Receivable
December 31, 2024

Customer        Total      Current    1-30 Days   31-60 Days   60+ Days
─────────────────────────────────────────────────────────────────────
Customer A      €2,000     €2,000
Customer B      €1,500     €1,000      €500
Customer C      €3,000     €1,500      €1,000      €500
Customer D      €1,000                              €500        €500
─────────────────────────────────────────────────────────────────────
Totals          €7,500     €4,500      €1,500      €1,000      €500

Estimated Uncollectible %:    2%        5%         10%         20%
Estimated Uncollectible:      €90       €75        €100        €100
─────────────────────────────────────────────────────────────────────
Total Estimated Uncollectible: €365

Calculation:

• Current: €4,500 × 2% = €90
• 1-30 Days: €1,500 × 5% = €75
• 31-60 Days: €1,000 × 10% = €100
• 60+ Days: €500 × 20% = €100
• Total: €365

Adjusting Entry:

If Allowance has €100 balance:

• Need: €365
• Have: €100
• Adjustment: €265

Journal Entry:

650000 Bad Debt Expense           €265
490000 Allowance for Doubtful Accounts          €265
To adjust allowance to estimated uncollectible

If Allowance has €400 balance:

• Need: €365
• Have: €400
• Adjustment: -€35 (reduce allowance)

Journal Entry:

490000 Allowance for Doubtful Accounts €35
650000 Bad Debt Expense                          €35
To adjust allowance to estimated uncollectible

PCN Accounts:

• 490000: Allowance for Doubtful Accounts (Class 4 - Contra-Asset)
• 650000: Bad Debt Expense (Class 6 - Expense)

Income Statement Approach (Percentage of Sales)

How it Works:

• Estimate bad debt expense as percentage of credit sales
• Calculate expense for period
• Add to allowance account

Example:

• Credit sales for year: €100,000
• Estimated bad debt percentage: 2%
• Bad debt expense: €100,000 × 2% = €2,000

Journal Entry:

650000 Bad Debt Expense         €2,000
490000 Allowance for Doubtful Accounts          €2,000
To record estimated bad debt expense

Note: This method focuses on matching expense with revenue, regardless of existing allowance balance.

Writing Off Specific Accounts

When Account is Determined Uncollectible:

Example:

• Customer A's account of €500 is determined uncollectible

Journal Entry:

490000 Allowance for Doubtful Accounts €500
410000 Accounts Receivable                        €500
To write off Customer A's uncollectible account

Important: Write-off doesn't affect Bad Debt Expense. Expense was already recorded when allowance was created.

Recovery of Written-Off Account

If Customer Later Pays:

Step 1: Reverse Write-Off

410000 Accounts Receivable        €500
490000 Allowance for Doubtful Accounts          €500
To reinstate account

Step 2: Record Collection

510000 Cash                        €500
410000 Accounts Receivable                    €500
To record collection of previously written-off account

Presentation on Balance Sheet

Accounts Receivable (Net):

Balance Sheet

Current Assets:
  Accounts Receivable              €7,500
  Less: Allowance for Doubtful Accounts  (365)
  Accounts Receivable (Net)        €7,135

Or:

Current Assets:
  Accounts Receivable (Net)        €7,135

Luxembourg VAT Considerations

VAT on Uncollectible Accounts:

When Account is Written Off:

• VAT may be recoverable if account is uncollectible
• Must follow Luxembourg VAT rules
• Proper documentation required
• May need to adjust VAT Payable

Example:

• Account of €1,170 (€1,000 + €170 VAT) written off
• If VAT is recoverable:

Journal Entry:

490000 Allowance for Doubtful Accounts €1,170
410000 Accounts Receivable                        €1,170

430000 VAT Payable                  €170
431000 VAT Recoverable                            €170
To write off account and recover VAT

Luxembourg Compliance Note:

For uncollectible accounts in Luxembourg:

• Allowance method is preferred
• Must estimate based on reasonable assumptions
• VAT recovery may be possible
• Must maintain proper documentation
• Affects taxable income
• Must comply with PCN requirements

Think It Through

Why is the allowance method preferred over the direct write-off method? How does it better match expenses with revenues?

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